ICEWEB, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2010

NOTE 10- COMPREHENSIVE INCOME (LOSS)

Comprehensive income is comprised of net income and other comprehensive income or loss. Other comprehensive income or loss refers to revenue, expenses, gains and losses that under accounting principles generally accepted in the United States are included in comprehensive income but excluded from net income as these amounts are recorded directly as an adjustment to stockholders’ equity.

Our other comprehensive income consists of unrealized gains on marketable securities available for sale of $1,872,000.

NOTE 11 – COMMITMENTS

We lease office space in Sterling, Virginia under a two-year operating lease that expires on March 31, 2011.  The office lease agreement has certain escalation clauses and renewal options. Additionally, we have lease agreements for computer equipment and an office copier/fax machine. Future minimum rental payments required under these operating leases are as follows:

 

Years ending September 30:
2010 (remaining six months)		$	37,611
2011			37,611
2012			-
2013			-
2014 and thereafter			-
		$	75,222

NOTE 12 - STOCKHOLDERS’ DEFICIT

 

During the six months ended March 31, 2010, in connection with the exercise of 18,836,200 stock options, the Company issued 18,836,200 shares of common stock for cash proceeds of $1,122,134.

 

During the six months ended March 31, 2010, we issued 2,000,000 shares of common stock at a per share price of $0.042, valued at $83,000 to an accredited investor. As of March 31, 2010 the Company had not yet received the proceeds from the investor and as a result the Company recorded the subscription receivable as a contra equity account on its balance sheet. The issuance was exempt from registration under the Securities Act of 1933 in reliance on an exemption provided by Section 4(2) of that act.

 

During the six months ended March 31, 2010, we sold 1,000,000 shares of common stock, valued at $100,000 to a Director for $40,000, and recognized stock based compensation expense of $90,000. The issuance was exempt from registration under the Securities Act of 1933 in reliance on an exemption provided by Section 4(2) of that act.

 

During the six months ended March 31, 2010, we sold 1,500,000 shares of common stock at a per share price of $0.10, valued at $150,000 to an accredited investor, and the issuance was exempt from registration under the Securities Act of 1933 in reliance on an exemption provided by Section 4(2) of that act.

During the six months ended March 31, 2010, we sold 3,000,000 shares of common stock at a per share price of $0.10, valued at $300,000 to an accredited investor, and the issuance was exempt from registration under the Securities Act of 1933 in reliance on an exemption provided by Section 4(2) of that act.

During the six months ended March 31, 2010, we issued 1,000,000 shares of common stock at a per share price of $0.17, valued at $170,000 to an accredited investor. The issuance was exempt from registration under the Securities Act of 1933 in reliance on an exemption provided by Section 4(2) of that act.

During the six months ended March 31, 2010 we issued 8,800,000 shares of restricted common stock at a per share price of $0.086, valued at $756,800, in lieu of pay to our employees.  The issuance was exempt from registration under the Securities Act of 1933 in reliance on an exemption provided by Section 4(2) of that act.

 

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ICEWEB, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2010

NOTE 12 - STOCKHOLDERS’ DEFICIT (continued)

Common Stock Warrants

 

A summary of the status of the Company’s outstanding common stock warrants as of March 31, 2010 and changes during the period ending on that date is as follows:

 

		Number of Warrants				Weighted Average Exercise Price
Common Stock Warrants
Balance at beginning of year			225,000			$	1.78
Granted			—				—
Exercised			—				—
Forfeited			75,000				6.00
Balance at end of period			150,000			$	0.55
Warrants exercisable at end of period			150,000			$	0.55
Weighted average fair value of warrants granted or re-priced during the period						$	—

 

The following table summarizes information about common stock warrants outstanding at March 31, 2010:

 

				Warrants Outstanding									Warrants Exercisable
Range of Exercise Price				Number Outstanding at March 31, 2010			Weighted Average Remaining Contractual Life		Weighted Average Exercise Price				Number Exercisable at March 31, 2010				Weighted Average Exercise Price
	0.50				145,000		4.55 Years			0.50				145,000				0.50
	2.00				5,000		1.31 Years			2.00				5,000				2.00
					150,000				$	0.55				150,000			$	0.55

NOTE 13 - STOCK OPTION PLAN

 

In August 2000, the Board of Directors adopted the 2000 Management and Director Equity Incentive and Compensation Plan (the “Plan”) for directors, officers and employees that provides for non-qualified and incentive stock options to be issued enabling holders thereof to purchase common shares of the Company at exercise prices determined by the Company’s Board of Directors. The Plan was approved by the Company’s stockholders in August 2001.

 

The purpose of the Plan is to advance the Company’s interests and those of its stockholders by providing a means of attracting and retaining key employees, directors and consultants. In order to serve this purpose, the Company believes the Plan encourages and enables key employees, directors and consultants to participate in its future prosperity and growth by providing them with incentives and compensation based on its performance, development and financial success. Participants in the Plan may include the Company’s officers, directors, other key employees and consultants who have responsibilities affecting our management, development or financial success.

 

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ICEWEB, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2010

NOTE 13 - STOCK OPTION PLAN (continued)

Awards may be made under the Plan in the form of Plan options, shares of the Company’s common stock subject to a vesting schedule based upon certain performance objectives (“Performance Shares”) and shares subject to a vesting schedule based on the recipient’s continued employment (“restricted shares”). Plan options may either be options qualifying as incentive stock options under Section 422 of the Internal Revenue Code of 1986, as amended or options that do not so qualify. Any incentive stock option granted under the Plan must provide for an exercise price of not less than 100% of the fair market value of the underlying shares on the date of such grant, but the exercise price of any incentive option granted to an eligible employee owning more than 10% of our common stock must be at least 110% of such fair market value as determined on the date of the grant. Only persons who are officers or other key employees are eligible to receive incentive stock options and performance share grants. Any non-qualified stock option granted under the Plan must provide for an exercise price of not less than 50% of the fair market value of the underlying shares on the date of such grant.

 

As amended in April, 2008, the Plan permits the grant of options and shares for up to 10,000,000 shares of the Company’s common stock. The Plan terminates 10 years from the date of the Plan’s adoption by the Company’s stockholders.

 

The term of each Plan option and the manner in which it may be exercised is determined by the Board of Directors, provided that no Plan option may be exercisable more than three years after the date of its grant and, in the case of an incentive option granted to an eligible employee owning more than 10% of the Company’s common stock, no more than five years after the date of the grant. The exercise price of the stock options may be paid in either cash, or delivery of unrestricted shares of common stock having a fair market value on the date of delivery equal to the exercise price, or surrender of shares of common stock subject to the stock option which has a fair market value equal to the total exercise price at the time of exercise, or a combination of the foregoing methods.

 

The fair value of stock options granted was estimated at the date of grant using the Black-Scholes options pricing model. The Company used the following assumptions for determining the fair value of options granted under the Black-Scholes option pricing model:

 

		March 31,
		2010		2009
Expected volatility		135% - 325%		87% - 198%
Expected term		0 - 5 Years		1 - 5 Years
Risk-free interest rate		0.03%		2.34% - 2.45%
Forfeiture Rate		0% - 45%		0% - 45%
Expected dividend yield		0%		0%

 

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ICEWEB, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2010

 

NOTE 13 - STOCK OPTION PLAN (continued)

 

The expected volatility was determined with reference to the historical volatility of the Company’s stock. The Company uses historical data to estimate option exercise and employee termination within the valuation model. The expected term of options granted represents the period of time that options granted are expected to be outstanding. The risk-free interest rate for periods within the contractual life of the option is based on the U.S. Treasury rate in effect at the time of grant.

 

For the three months ended March 31, 2010, total stock-based compensation charged to operations for option-based arrangements amounted to $330,876. At March 31, 2010, there was approximately $643,511 of total unrecognized compensation expense related to non-vested option-based compensation arrangements under the Plan.

 

A summary of the status of the Company’s outstanding stock options as of March 31, 2010 and changes during the period ending on that date is as follows:

 

		Number of Options				Weighted Average Exercise Price
Stock options
Balance at beginning of period			10,944,483			$	0.27
Granted			22,065,000				0.07
Exercised			(18,836,200	)			0.07
Forfeited			(46,979	)			3.80
Balance at end of period			14,126,304			$	0.23
Options exercisable at end of period			12,001,729			$	0.26
Weighted average fair value of options granted during the year						$	0.07

 

The following table summarizes information about employee stock options outstanding at March 31, 2010:

 

				Options Outstanding									Options Exercisable
Range of Exercise Price				Number Outstanding at March 31, 2010			Weighted Average Remaining Contractual Life		Weighted Average Exercise Price				Number Exercisable at March 31, 2010				Weighted Average Exercise Price
$	0.001-0.25				10,198,800		1.49 Years		$	0.11				8,222,633			$	0.11
	0.30-0.48				535,000		2.06 Years			0.45				516,250				0.45
	0.54-0.60				2,475,004		2.40 Years			0.58				2,345,904				0.59
	0.61-0.80				917,500		1.41 Years			0.72				916,942				0.71
					14,126,304				$	0.24				12,001,729			$	0.26

 

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ICEWEB, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2010

 

NOTE 14 - SEGMENT REPORTING

 

Although the Company has a number of operating divisions, separate segment data has not been presented as they meet the criteria for aggregation as permitted by ASC Topic 280, “Segment Reporting” (formerly Statement of Financial Accounting Standards (SFAS) No. 131, “Disclosures About Segments of an Enterprise and Related Information”).

Our chief operating decision-maker is considered to be our Chief Executive Officer (CEO). The CEO reviews financial information presented on a consolidated basis for purposes of making operating decisions and assessing financial performance. The financial information reviewed by the CEO is identical to the information presented in the accompanying consolidated statements of operations. Therefore, the Company has determined that it operates in a single operating segment, specifically, web communications services. For the periods ended March 31, 2010 and 2009 all material assets and revenues of the Company were in the United States.

NOTE 15 – SUBSEQUENT EVENTS

For purposes of determining whether a post-balance sheet event should be evaluated to determine whether it has an effect on the financial statements for the three months ended March 31, 2010, subsequent events were evaluated by the Company as of May 17, 2010, the date on which the unaudited consolidated financial statements for the three months ended March 31, 2010, were available to be issued.

 

Other than the disclosures shown, we did not identify any events or transactions that should be recognized or disclosed in the accompanying financial statements.

 

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION

 

The following analysis of our consolidated financial condition and results of operations for the three and six months ended March 31, 2010 and 2009 should be read in conjunction with the consolidated financial statements, including footnotes, appearing elsewhere in this quarterly report.

 

OVERVIEW

 

Since 2005, the Company has been focused on serving the commercial and federal markets with network security products and proprietary on-line software solutions. In fiscal 2008, the Company acquired INLINE Corporation (now known as IceWEB Storage Corporation), a data storage manufacturing company.

 

In March, 2009, the Company sold its wholly owned subsidiary, IceWEB Virginia, Inc. to an unrelated 3 rd party, and in the process exited its low-margin IT re-seller business products business to further focus on the higher margin data storage manufacturing business.

 

At the close of fiscal year 2009, the Company has three key product offerings:

 

•

IceWEB Unified Network Storage Solutions

•

Purpose Built Network/Data Appliances

•

Cloud Computing Products/Services

 

In addition, we offer small and medium sized businesses (“SMBs”) hosted access to enterprise-class applications delivered via the Internet for a reasonable monthly fee. These rapidly growing Cloud Computing offerings include such hosted applications as Microsoft Exchange Server, Sharepoint, BlackBerry Enterprise Server, Good Messaging Server, SPAM and Virus protection, and advanced Email Encryption services. Our current customer base consists of nearly 900 organizations worldwide in both the public and private sectors.

 

•

On November 15, 2006, the Company acquired the assets of True North Federal Solutions Group for $350,000 of which $250,000 was paid in cash and $100,000 due upon future terms of the agreement. Under the terms of the agreement, IceWEB acquired the customer database, forecast, contract renewals, and GSA schedule of True North Federal. The revenue generated to IceWEB from this division since the acquisition, exceeded the revenue from the discontinued PatriotNet and IPS operations.

•

On December 22, 2007, we acquired 100% of the outstanding stock of Inline Corporation for $2,412,731 in cash, plus 503,356 shares of IceWEB common stock valued at $276,846, the fair market value on the date of acquisition. The acquisition was accounted for using the purchase method of accounting. The results of operations are included in the financial statements from the date of acquisition. Inline is a leading provider of intelligent enterprise data storage solutions and services for the geospatial intelligence marketplace. Inline’s proprietary products include reliable, high performance Storage Area Network Solutions, Network Attached Storage, and Direct Attached Storage and the rapidly expanding OEM Storage Centric Appliances. Today, Inline has developed its fifth generation of advanced data storage solutions, marketed under the brands TruEnterprise and FileStorm. All Inline systems function in a heterogeneous operating system environment, including Windows, UNIX and Linux. The purchase of Inline Corporation included the acquisition of assets of $2,688,795, and liabilities of $614,668.

•

On March 31, 2009, we sold our interest in IceWEB Virginia, Inc. (dba IceWEB Solutions Group, which included the assets acquired from True North Federal Solutions Group) subsidiary to an unrelated third party in exchange for the assumption of approximately $3.2 million in liabilities and 1,000,000 shares of our common stock valued at $80,000. IceWEB Virginia, Inc. was a provider of computer network security products and services such as access control, wide area network optimization, content filtering, email security, intrusion detection, to the Federal, State, and Local government entities. This subsidiary accounted for 43% and 91% of our revenues for fiscal years 2009 and 2008, respectively. We sold this business in order for us to be able to focus on our high margin storage business.

 

 

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We generate revenues from the manufacture and sale of data storage appliances and servers, the sale of software services, application development, network integrated technology, and third party hardware sales. We believe that the key factors to our continued growth and profitability include the following:

 

•	Continued focus on the GIS market and expanding our channels of distribution with OEM partners

•	Continued investment in product development and research efforts

•	Raising approximately $3 million of additional working capital to expand our marketing, research and development, and restructure our debt.

•	Improving our internal financial reporting systems and processes.

 

CRITICAL ACCOUNTING POLICIES

 

The discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates based on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

 

A summary of significant accounting policies is included in Note 1 to the audited consolidated financial statements included for the year ended September 30, 2009 and notes thereto contained on Form 10-K of the Company as filed with the Securities and Exchange Commission. Management believes that the application of these policies on a consistent basis enables us to provide useful and reliable financial information about the company’s operating results and financial condition.

 

Financial Reporting Release No. 60, which was released by the U.S. Securities and Exchange Commission, encourages all companies to include a discussion of critical accounting policies or methods used in the preparation of financial statements. Our consolidated financial statements include a summary of the significant accounting policies and methods used in the preparation of our consolidated financial statements. Management believes the following critical accounting policies affect the significant judgments and estimates used in the preparation of the financial statements.

 

Use of Estimates - Management’s Discussion and Analysis or Plan of Operations is based upon our unaudited consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these consolidated financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues, and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, management evaluates these estimates, including those related to allowances for doubtful accounts receivable, the carrying value of property and equipment and long-lived assets, and the value of stock-option based compensation. Management bases these estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis of making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

 

Accounting for Stock Based Compensation - Effective October 1, 2005, we adopted the fair value recognition provisions of ASC Topic 718, “Compensation – Stock Compensation (Formerly SFAS No. 123 (R), “Share-Based Payments using the modified-prospective-transition method. ASC Topic 718 establishes the financial accounting and reporting standards for stock-based compensation plans. As required by ASC Topic 718, we recognize the cost resulting from all stock-based payment transactions including shares issued under our stock option plans in the financial statements. The adoption of ASC Topic 718 will have a negative impact on our future results of operations.

 

Revenue Recognition - We follow the guidance of Accounting Standards Codification (ASC) Topic 605, “Revenue Recognition” (formerly Staff Accounting Bulletin (SAB) No. 104, “Revenue Recognition”) for revenue recognition. In general, we record revenue when persuasive evidence of an arrangement exists, services have been rendered or product delivery has occurred, the sales price to the customer is fixed or determinable, and collectability is reasonably assured. The following policies reflect specific criteria for our various revenues streams:

 

•

Revenues from sales of products are generally recognized when products are shipped unless the Company has obligations remaining under sales or licensing agreements, in which case revenue is either deferred until all obligations are satisfied or recognized ratably over the term of the contract.

•

Revenue from services is recorded as it is earned. Commissions earned on third party sales are recorded in the month in which contracts are awarded. Customers are generally billed every two weeks based on the units of production for the project. Each project has an estimated total which is based on the estimated units of production and agreed upon billing rates.

•

Amounts billed in advance of services being provided are recorded as deferred revenues and recognized in the consolidated statement of operations as services are provided.

 

 

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THREE AND SIX MONTHS ENDED MARCH 31, 2010 COMPARED TO THE THREE AND SIX MONTHS ENDED MARCH 31, 2009

 

The following table provides an overview of certain key factors of our results of operations for the three and six months ended March 31, 2010 as compared to the three and six months ended March 31, 2009:

 

		Three months ended March 31,								Six months ended March 31,
		2010				2009				2010				2009
Net Revenues		$	1,011,205			$	1,369,702			$	1,612,022			$	3,110,290
Cost of sales			456,094				806,391				729,718				2,074,066
Operating Expenses:
Marketing and selling			472,359				195,825				785,217				422,877
Depreciation and amortization			162,926				170,798				330,399				347,045
Research and development			105,745				76,865				185,311				156,431
General and administrative			1,560,401				681,699				2,654,370				1,135,050
Total operating expenses			2,301,431				1,125,187				3,955,297				2,061,403
Loss from operations			(1,746,320	)			(561,876	)			(3,072,993	)			(1,025,179	)
Total other income (expense)			(141,995	)			3,283,816				(274,956	)			3,088,084
Net income (loss)		$	(1,888,315	)		$	2,721,940			$	(3,347,949	)		$	2,062,905

 

Other Key Indicators:

 

		Three months ended March 31,								Six months ended March 31,
		2010				2009				2010				2009
Cost of sales as a percentage of revenues			45.1	%			58.9	%			45.3	%			66.7	%
Gross profit margin			54.9	%			41.1	%			54.7	%			33.3	%
General and administrative expenses as a percentage of revenues			154.3	%			49.8	%			164.7	%			36.5	%
Total operating expenses as a percentage of revenues			227.6	%			82.1	%			245.4	%			66.3	%

Six Month Period ended March 31, 2010

 

Revenues

 

For the six months ended March 31, 2010, we reported revenues of $1,612,022 as compared to revenues of $3,110,290 for the six months ended March 31, 2009, a decrease of $1,498,268 or approximately 48%. The decrease is primarily due to the Company’s focus on our high margin data storage business unit and the related decrease in our third party product sales through IceWEB Solutions Group. Storage revenue accounted for approximately 95% of our revenue for the six month period ended March 31, 2010 as compared to 43% in the year-ago period.

 

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Cost of Sales

 

Our cost of sales consists primarily of component parts for the manufacture of our storage products. For the six months ended March 31, 2010, cost of sales was $729,718, or approximately 45% of revenues, compared to $2,074,066, or approximately 66.6% of revenues, for the six months ended March 31, 2009. The decrease in costs of sales as a percentage of revenue and the corresponding increase in our gross profit margin for the six months ended March 31, 2010 as compared to the six months ended March 31, 2009 was the result of improved mix of higher margin storage products during the six months ended March 31, 2010 as a percentage of total revenue. We anticipate that our gross profit margins will continue to improve through the balance of fiscal 2010.

 

Total Operating Expenses

 

Our total operating expenses increased approximately 92% to $3,955,297 for the six months ended March 31, 2010 as compared to $2,061,403 for the six months ended March 31, 2009. These changes include:

 

•         Sales and marketing expense. Sales and marketing expense includes salaries, commission, occupancy, telephone, travel, and entertainment expenses for direct sales personnel.  For the six months ended March 31, 2010, sales and marketing costs were $785,217 as compared to $422,877 for the six months ended March 31, 2009, an increase of $362,340 or approximately 86%. The increase was due primarily to hiring additional sales and marketing personnel to support our channel distribution sales and marketing approach during the six months ended March 31, 2010.

 

•         Depreciation and amortization expense. For the six months ended March 31, 2010, depreciation and amortization expense amounted to $330,399 as compared to $347,045 for the six months ended March 31, 2009, a decrease of $16,646 or 5%.

•         Research and Development. For the six months ended March 31, 2010, research and development costs were $185,311 as compared to $156,431 for the six months ended March 31, 2009, an increase of $28,880 or approximately 18%.

 

•         General and administrative expense. For the six months ended March 31, 2010, general and administrative expenses were $2,654,370 as compared to $1,135,049 for the six months ended March 31, 2009, an increase of $1,519,320 or approximately 134%. For the six months ended March 31, 2010 and 2009 general and administrative expenses consisted of the following:

 

		Fiscal Q2				Fiscal Q2
		2010				2009
Occupancy		$	10,661			$	7,865
Consulting			82,903				60,142
Employee compensation			2,364,708				926,007
Professional fees			54,550				14,194
Internet/Phone			5,148				27,423
Travel/Entertainment			517				1,276
Investor Relations			29,964				19,778
Insurance			23,953				20,889
Other			81,966				57,476
		$	2,654,370			$	1,135,050

 

 

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•

For the six months ended March 31, 2010, Occupancy expense increased to $10,661 as compared to $7,865. Occupancy expense is higher due to the Company’s relocation to its manufacturing facility in Sterling, Virginia.

•

For the six months ended March 31, 2010, Consulting expense increased to $82,903 as compared to $60,142. Consulting expense increased primarily as a result of recruiting costs incurred to hire engineering, sale and marketing personnel.

•

For the six months ended March 31, 2010, salaries and related expenses increased to $2,364,708 as compared to $926,007, an increase of $1,438,701. The increase is due primarily to an increase in non-cash compensation expense of $1,471,396.

•

For the six months ended March 31, 2010, Professional fees expense increased to $54,550 as compared to $14,194. Professional fees expense increased due to increased costs related to intellectual property patent applications and other legal fees.

•

For the six months ended March 31, 2010, travel and entertainment expense decreased to $517 as compared to $1,276.

•

For the six months ended March 31, 2010 Other expense amounted to $81,966 as compared to $57,476 for the six months ended March 31, 2009, an increase of $24,491.

•

For the six months ended March 31, 2010 Investor relations expense increased to $29,964 as compared to $19,778 for the six months ended March 31, 2009. The increase is due to increased investor relations activity.

We anticipate that general and administrative expenses will decline for the balance of fiscal 2010, as we expect to incur lower of share-based expenses.

 

LOSS FROM OPERATIONS

 

We reported a loss from operations of $3,072,993 for the six months ended March 31, 2010 as compared to a loss from operations of $1,025,179 for the six months ended March 31, 2009, an increased loss of $2,047,814 or approximately 200%.

 

OTHER INCOME (EXPENSES)

 

Gain from sale of subsidiary. The gain on sale of subsidiary of $3,452,236 resulted from the sale of IceWEB Virginia, Inc. in March, 2009.  We did not have a similar transaction in the six month period ended March 31, 2010.

 

Interest Income. We did not earn any interest income for the six months ended March 31, 2010, as compared to interest income of $1,142 in the six month period ended March 31, 2009.  Interest income represented interest earned on interest bearing cash accounts.

 

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Interest Expense.  For the six months ended March 31, 2010, interest expense amounted to $274,956 as compared to $365,294 for the six months ended March 31, 2009, a decrease of $90,338 or 25%. The decrease in interest expense is primarily attributable to the decrease in borrowings and certain interest bearing liabilities related to the our notes payable. Also, during the six months ended March 31, 2010, we amortized deferred financing costs of $13,265, as compared to $40,233 during the six months ended March 31, 2009.

 

NET INCOME/ LOSS

 

Our net loss was $3,347,949 for the six months ended March 31, 2010 compared to net income of $2,062,905 for the six months ended March 31, 2009.

Three Month Period ended March 31, 2010

 

Revenues

 

For the three months ended March 31, 2010, we reported revenues of $1,011,205 as compared to revenues of $1,369,702 for the three months ended March 31, 2009, a decrease of $358,497 or approximately 26%. The decrease is primarily due to the Company’s focus on our high margin data storage business unit and the related decrease in our third party product sales through IceWEB Solutions Group. For the three months ended March 31, 2010, storage revenue accounted for approximately 95% of our revenue as compared to 66% of our revenue during the three months ended March 31, 2009.

 

Cost of Sales

 

Our cost of sales consists of component parts for the manufacture of our storage products. For the three months ended March 31, 2010, cost of sales was $456,094, or approximately 45% of revenues, compared to $806,391, or approximately 59% of revenues, for the three months ended March 31, 2009. The decrease in costs of sales as a percentage of revenue and the corresponding increase in our gross profit margin for the three months ended March 31, 2010 as compared to the three months ended March 31, 2009 was the result of improved mix of higher margin storage products during the three months ended March 31, 2010 as a percentage of total revenue.

 

Total Operating Expenses

 

Our total operating expenses increased approximately 105% to $2,301,431 for the three months ended March 31, 2010 as compared to $1,125,187 for the three months ended March 31, 2009. These changes include:

 

•           Sales and marketing expense. For the three months ended March 31, 2010, sales and marketing expenses were $472,359 as compared to $195,825 for the three months ended March 31, 2009, an increase of $276,534 or approximately 141%. The increase was due to increased headcount and sales and marketing expense related to the roll-out of our channel sales program during the three months ended March 31, 2010.

 

•           Depreciation and amortization expense. For the three months ended March 31, 2010, depreciation and amortization expense amounted to $162,926 as compared to $170,798 for the three months ended March 31, 2009, a decrease of $7,872 or 5%.

 

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•           General and administrative expense. For the three months ended March 31, 2010, general and administrative expenses were $1,560,401 as compared to $681,699 for the three months ended March 31, 2009, an increase of $878,702 or approximately 129%. For the three months ended March 31, 2010 and 2009 general and administrative expenses consisted of the following:

 

		Fiscal Q2				Fiscal Q2
		2010				2009
Occupancy		$	3,175			$	2,095
Consulting			53,130				41,659
Employee compensation			1,396,515				573,293
Professional fees			22,500				2,747
Internet/Phone			1,397				10,397
Travel/Entertainment			363				744
Investor Relations			17,870				16,620
Insurance			10,737				6,400
Other			54,714				27,744
		$	1,560,401			$	681,699

 

•

For the three months ended March 31, 2010, Occupancy expense increased to $3,175 as compared to $2,095.

•

For the three months ended March 31, 2010, Consulting expense increased to $53,130 as compared to $41,659, an increase of $11,471 or 27.5%. Consulting expense increased as a result of increased support costs for internal accounting systems.

•

For the three months ended March 31, 2010, salaries and related expenses increased to $1,396,515 as compared to $573,293, an increase of $823,222. The increase is due primarily to an increase in non-cash compensation expense of $818,175, which is comprised of increased stock-based compensation expense of $636,879, and increased amortization of deferred compensation related to employee stock options of $181,296.

•

For the three months ended March 31, 2010, Professional fees expense increased to $22,500 as compared to $2,747.  Professional fees expense increased primarily as a result of legal fees incurred related to business development and on-going litigation activities.

•

For the three months ended March 31, 2010, travel and entertainment expense decreased to $363 as compared to $744. Travel and entertainment expense decreased as a result of limited travel by sales and marketing and general cost-cutting measures put in place by the Company.

•

For the three months ended March 31, 2010 Other expense amounted to $54,714 as compared to $27,744 for the three months ended March 31, 2009, an increase of 26,970.  The increase was due primarily to increase hosting fees and other headcount related expenses, as we have added resources to support our channel sales strategy.

•

For the three months ended March 31, 2010 Investor relations expense increased to $17,870 as compared to $16,620 for the three months ended March 31, 2009.

 

 

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LOSS FROM OPERATIONS

 

We reported a loss from operations of $1,746,320 for the three months ended March 31, 2010 as compared to a loss from operations of $561,876 for the three months ended March 31, 2009, an increase of $1,184,445 or approximately 211%.

 

OTHER INCOME (EXPENSES)

 

Gain from sale of subsidiary. The gain on sale of subsidiary of $3,452,236 resulted from the sale of IceWEB Virginia, Inc. in March, 2009.  We did not have a similar transaction in the three month period ended March 31, 2010.

 

Interest Income. Interest income for the three months ended March 31, 2009 amounted to $660 and represented interest earned on interest bearing cash accounts. We did not have a similar interest bearing balances in the three month period ended March 31, 2010.

 

Interest Expense. For the three months ended March 31, 2010, interest expense amounted to $141,995 as compared to $169,080 for the three months ended March 31, 2009, a decrease of $27,085 or 16%. The decrease in interest expense is primarily attributable to the decrease in borrowings and certain interest bearing liabilities related to the acquisition of Inline Corporation. Also, during the three months ended March 31, 2010, we amortized deferred financing costs of $6,875, as compared to $7,968 during the three months ended March 31, 2009.

 

NET INCOME/ LOSS

 

Our net loss was $1,888,315 for the three months ended March 31, 2010 compared to net income of $2,721,940 for the three months ended March 31, 2009.

 

LIQUIDITY AND CAPITAL RESOURCES

 

Liquidity is the ability of a company to generate funds to support its current and future operations, satisfy its obligations and otherwise operate on an ongoing basis. The following table provides an overview of certain selected balance sheet comparisons between March 31, 2010 and September 30, 2009:

 

		March 31,				September 30,				$					%
		2010				2009				Change					Change
Working Capital			(2,469,593	)			(3,158,232	)			688,639				(21.8	)%
Cash			147,300				63,310				83,990				132.7	%
Accounts receivable, net			891,382				424,919				466,463				109.8	%
Inventory			151,937				151,361				576				0.4	%
Total current assets			1,244,640				671,160				573,480				85.4	%
Property and equipment, net			580,752				752,162				(171,410	)			(22.8	)%
Marketable securities held for sale			1,920,000				-				1,920,000				100.0	%
Intangibles, net			668,496				790,043				(121,547	)			(15.4	)%
Total assets			4,427,208				2,226,684				2,200,524				98.8	%
Accounts payable and accrued liabilities			1,933,104				1,971,376				(38,272	)			(1.9	)%
Notes payable-current			1,759,410				1,847,755				(88,345	)			4.8	%
Deferred revenue			21,719				10,261				(11,458	)			(111.7	)%
Total current liabilities			3,714,233				3,829,392				(115,159	)			(3.0	)%
Notes payable-long term			1,011,480				934,756				76,725				8.2	%
Total liabilities			4,725,713				4,764,148				(38,435	)			(0.8	)%
Accumulated deficit			(26,006,507	)			(22,658,559	)			(3,347,948	)			14.6	%
Accumulated other comprehensive income			1,872,000				-				1,872,000				100.0	%
Stockholders’ deficit			(298,505	)			(2,537,464	)			2,238,959				88.2	%

 

 

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Net cash used in operating activities was $1,431,078 for the six months ended March 31, 2010 as compared to net cash used in operating activities of $591,196 for the six months ended March 31, 2009, an increase of $839,882.  For the six months ended March 31, 2010, we had a loss of $3,347,949 offset by non-cash items such as depreciation and amortization expense of $330,399, share-based compensation expense of $2,102,775, amortization of deferred finance costs of $13,265, and decreases from changes in assets and liabilities of $579,568. During the six months ended March 31, 2010 we experienced an increase in accounts receivable of $466,464, and a decrease in accounts payable during the period of $38,272.  For the six months ended March 31, 2009, we had net income of $2,062,905 and non-cash items such as depreciation and amortization expense of $347,045, share-based compensation expense of $631,379, amortization of deferred finance costs of $34,920, offset by the gain on sale of our IceWEB Virginia subsidiary in the amount of $3,452,235, and decreases from changes in assets and liabilities of $223,526. During the six months ended March 31, 2009 we experienced a decrease in accounts receivable of $2,253,828, which was offset by a decrease in accounts payable during the period of $6,518,451.

 

Net cash used in investing activities for the six months ended March 31, 2010 was $85,444 as compared to net cash used in investing activities of $15,118 for the six months ended March 31, 2009. During the six months ended March 31, 2010, we used cash of $37,444 for property and equipment purchases and $48,000 to acquire 160,000,000 shares of VOIS Inc. common stock.  During the six months ended March 31, 2009, we used cash of $15,118 for property and equipment purchases.

 

Net cash provided by financing activities for the six months ended March 31, 2010 was $1,600,512 as compared to net cash provided of $609,892 for the six months ended March 31, 2009.  For the six months ended March 31, 2010, net cash provided by financing activities related to proceeds received from notes payable of $799,460 which were advances under our factoring line with Sand Hill Finance LLC, proceeds from the exercise of common stock options of $1,122,134, and proceeds from the sale or restricted stock of $490,000, offset by repayments on notes payable of $811,082 which were to pay down the balance on the Sand Hill Finance LLC factoring line.  For the six months ended March 31, 2009, net cash provided by financing activities related to proceeds received from notes payable of $6,175,684 which were advances under our factoring line with Sand Hill Finance LLC, and proceeds from the exercise of common stock options of $163,800, offset by repayments on notes payable of $5,684,478 which were to pay down the balance on the Sand Hill Finance LLC factoring line, and repayments of equipment financing of $45,114.

 

At March 31, 2010 we had a working capital deficit of $2,469,593 and an accumulated deficit of $26,006,507.  The report from our independent registered public accounting firm on our audited financial statements for the fiscal year ended September 30, 2009 contained an explanatory paragraph regarding doubt as to our ability to continue as a going concern as a result of our net losses in operations. While our sales decreased significantly during the six months ended March 31, 2010, our gross profit margin was approximately 55% and our sales were not sufficient to pay our operating expenses. We reported a net loss of $3,347,949 for the six months ended March 31, 2010.  There are no assurances that we will report income from operations in any future periods.

 

Historically, our revenues have not been sufficient to fund our operations and we have relied on capital provided through the sale of equity securities, and various financing arrangements and loans from related parties. At March 31, 2010 we had cash on hand of $147,300.  In fiscal 2006, we entered into a receivable factoring agreement with Sand Hill Finance, LLC under which we can sell certain accounts receivable to the lender on a full recourse basis at 80% of the face amount of the receivable up to an aggregate of $3.0 million. At March 31, 2010 we owed Sand Hill Finance, LLC $1,759,410 under this accounts receivable line.

 

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We do not have any commitments for capital expenditures. In connection with our annual report for our fiscal year ending September 30, 2010 our management will be required to provide an assessment of the effectiveness of our internal control over financial reporting, including a statement as to whether or not internal control over financial reporting is effective. In order to comply with this requirement we will need to engage a consulting firm to undertake an analysis of our internal controls. We have yet to engage such a consulting firm and are unable at this time to predict the costs associated with our compliance with Section 404 of Sarbanes-Oxley Act of 2002. We do not presently have any external sources of working capital other than what may be available under the factoring agreement with Sand Hill Finance and loans from related parties. Our working capital needs in future periods are dependent primarily on the rate at which we can increase our revenues while controlling our expenses and decreasing the use of cash to fund operations. Additional capital may be needed to fund acquisitions of additional companies or assets, although we are not a party to any pending agreements at this time and, accordingly, cannot estimate the amount of capital which may be necessary, if any, for acquisitions.

 

As long as our cash flow from operations remains insufficient to completely fund operations, we will continue depleting our financial resources and seeking additional capital through equity and/or debt financing. Under the terms of the financing agreement with Sand Hill Finance, LLC we agreed not to incur any additional indebtedness other than trade credit in the ordinary course of business. These covenants may limit our ability to raise capital in future periods.

 

There can be no assurance that acceptable financing can be obtained on suitable terms, if at all. Our ability to continue our existing operations and to continue growth strategy could suffer if we are unable to raise the additional funds on acceptable terms which will have the effect of adversely affecting our ongoing operations and limiting our ability to increase our revenues and maintain profitable operations in the future. If we are unable to secure the necessary additional working capital as needed, we may be forced to curtail some or all of our operations.

 

Recent Accounting Pronouncements

 

None.

 

Item 3.    Quantitative and Qualitative Disclosures About Market Risk

 

None.

 

Item 4.    Controls and Procedures

 

Evaluation of disclosure controls and procedures. Our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”) have evaluated the effectiveness of our disclosure controls and procedures (as defined in the Exchange Act Rules 13a-15(e) and 15d-15(e)) as of the end of the period covered by the Quarterly Report (the “evaluation date’). They have concluded that, as of the evaluation date, these disclosure controls and procedures were effective to ensure that material information relating to us and our consolidated subsidiaries would be made known to them by others within those entities and would be disclosed on a timely basis.

 

Changes in internal control over financial reporting. There were no changes to internal controls over financial reporting that occurred during the three months ended March 31, 2010, that have materially affected, or are reasonably likely to materially impact, our internal controls over financial reporting.

 

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PART II - OTHER INFORMATION

 

Item 1.         Legal Proceedings

 

At March 31, 2010 we are the subject of, or party to, four known, pending or threatened, legal actions.  As of the date of this report on Form 10-Q, none of the legal proceedings have been resolved.  Following is a discussion of each:

1.   We were named as the defendant in a legal proceeding brought by Avnet, Inc. (the plaintiff) in the United States District Court for the Eastern District of Virginia, Alexandria Division.  The plaintiff asserts that the Company breached purchase orders to which the plaintiff was a party involving the purchase of goods and services from plaintiff.

  

2.   We were named as the defendant in a legal proceeding brought by Vencore Solutions, LLC (the plaintiff) in the Circuit Court of the State of Oregon for the County of Multnomah.  The plaintiff asserts that Iceweb failed to make certain lease payments.

 

3.   We were named as the defendant in a legal proceeding brought by International Business Machines Corporation-IBM Internet Security Systems Division (the plaintiff) in the Supreme Court f the State of New York, County of Westchester.  The plaintiff asserts that the Company failed to pay certain invoices for goods or services sold to IceWeb Virginia, Inc. by plaintiff for resale to its customers.

 

4.   We were named as the defendant in a legal proceeding brought by Charles Rothermel (the plaintiff) in the Equal Opportunity Commission.  The plaintiff asserts that Iceweb discriminated against him on the basis of age.

 

From time to time, we may become involved in various lawsuits and legal proceedings, which arise in the ordinary course of business. However, litigation is subject to inherent uncertainties, and an adverse result in these or other matters may arise from time to time that may harm our business.

 

Item 1A.      Risk Factors

 

In addition to the other information set forth in this report, you should carefully consider the factors discussed under the heading “Risk Factors” in our Annual Report on Form 10-K filed on December 29, 2009, which could materially affect our business operations, financial condition or future results. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business operations and/or financial condition. There have been no material changes to our risk factors since the filing of our Form 10-K.

 

Item 2.         Unregistered Sales of Equity Securities and Use of Proceeds

 

During the six months ended March 31, 2010, we issued 2,000,000 shares of common stock at a per share price of $0.042, valued at $83,000 to an accredited investor. As of March 31, 2010 the Company had not yet received the proceeds from the investor and as a result the Company recorded the subscription receivable as a contra equity account on its balance sheet. The issuance was exempt from registration under the Securities Act of 1933 in reliance on an exemption provided by Section 4(2) of that act.

 

During the six months ended March 31, 2010, we sold 1,000,000 shares of common stock, valued at $100,000 to a Director for $40,000, and recognized stock based compensation expense of $90,000. The issuance was exempt from registration under the Securities Act of 1933 in reliance on an exemption provided by Section 4(2) of that act.

 

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During the six months ended March 31, 2010, we sold 1,500,000 shares of common stock at a per share price of $0.10, valued at $150,000 to an accredited investor, and the issuance was exempt from registration under the Securities Act of 1933 in reliance on an exemption provided by Section 4(2) of that act.

During the six months ended March 31, 2010, we sold 3,000,000 shares of common stock at a per share price of $0.10, valued at $300,000 to an accredited investor, and the issuance was exempt from registration under the Securities Act of 1933 in reliance on an exemption provided by Section 4(2) of that act.

In March, 2010 we issued 8,800,000 shares of restricted common stock at a per share price of $0.086, valued at $756,800, in lieu of pay to our employees.  The issuance was exempt from registration under the Securities Act of 1933 in reliance on an exemption provided by Section 4(2) of that act.

During the six months ended March 31, 2010, we issued 1,000,000 shares of common stock at a per share price of $0.17, valued at $170,000 to an accredited investor for consulting services.  The issuance was exempt from registration under the Securities Act of 1933 in reliance on an exemption provided by Section 4(2) of that act.

 

Item 3.         Defaults Upon Senior Securities

 

None.

 

Item 4.         Submission of Matters to a Vote of Security Holders

 

None.

 

Item 5.         Other Information

 

None.

 

Item 6.         Exhibits

 

Exhibit Number		Description
31.1		Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 *
31.2		Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 *
32.1		Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 *
32.2		Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 *

 

* Filed herein

 

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SIGNATURES

 

In accordance with the requirements of the Exchange Act, the registrant has caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

	ICEWEB, INC.
	By:	/s/ John R. Signorello
May 17, 2010	John R. Signorello,
	Chief Executive Officer, principal executive officer
	By:	/s/ Mark B. Lucky
May 17, 2010	Mark B. Lucky
	Chief Financial Officer, principal financial and accounting officer

 

 

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